Does wedge size matter? Financial reporting quality and effective regulation of dual-class firms

Ido Baum (College of Magement - Striks Faculty of Law)
Rimona Palas (College of Law & Business)
Dov Solomon (College of Law & Business)
Dalit Gafni (College of Management )

Abstract

Dual-class capital structures create a gap (“wedge”) between voting rights and cash flow rights. Our analysis indicates that the larger the wedge, the higher the quality of financial reporting, reflecting a tradeoff between the dilution of voting rights and enhancement of the credibility of the information provided to investors. It suggests that increasing management’s insulation from market pressures is stronger than agency costs and thus reduces the motivation to manipulate earnings. Therefore, with respect to financial reporting, a nuanced regulation restricting the size of the wedge may not be more effective.

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